October 25, 2002

October 25, 2002 | Commentary on

ED102502:  Two Cheers for Bankruptcy

Many normal people -- not to mention politicians looking to exploit the latest headline -- talk about corporate bankruptcy as if it's some sort of financial scam, a gimmick perpetrated by malevolent corporations to avoid paying their bills. So it's not surprising to see some politicians on the campaign trail using high-profile bankruptcies as an excuse to play politics, blaming the Bush administration for mismanaging the economy.

This may make good political theater, but it's economic nonsense. Bankruptcy certainly isn't good news, but it's absurd to think that corporations deliberately choose it. It's equally silly to blame President Bush. The events cited most often in recent bankruptcy filings -- bad corporate decisions and the stock-market bubble -- occurred mostly in the late 1990s.

It's important to understand that bankruptcy isn't a cataclysmic, end-of-the-world event. In most cases, a company continues to operate. Most jobs are preserved, and consumers still have access to the firm's products. This is because bankruptcy laws are designed to minimize the economic fallout when a company falls into the red.

In effect, bankruptcy laws give a troubled firm a chance to reorganize. Debts are rescheduled, contracts renegotiated, and unprofitable divisions sold or terminated. These are usually difficult and unpopular steps, but they sure beat the alternative. Without bankruptcy laws, a company with cash-flow problems might have to shut its doors immediately and keep them shut forever. All of its jobs vanish, and the market loses a provider of goods and services.

The WorldCom bankruptcy is a good example. Despite its troubles, the telecommunications giant still employs 60,000 workers and serves millions of consumers. It's impossible to know whether the company will become profitable again, but even in a worst-case scenario, Chapter 11 bankruptcy creates an opportunity for orderly liquidation. This minimizes the damage to the overall economy while also serving the interests of workers and consumers.

Workers and consumers are just two of many parties that benefit from properly designed bankruptcy laws. Shareholders and creditors also would experience huge losses if companies couldn't reorganize. When firms permanently shut down, their only remaining "asset" is the money that can be raised by disposing of property and equipment at fire-sale prices. Shareholders almost certainly wind up losing their entire investment, and creditors -- such as banks and vendors -- are lucky to recover a small fraction of what they're owed.

Some critics argue that bankruptcy laws are too easy. This claim isn't without merit, and policymakers should ensure the system isn't exploited. But it's important not to throw out the good with the bad. Many major companies, including Continental Airlines, Texaco and Southland Corporation (7-Eleven stores), are operating today because bankruptcy laws allowed them to reorganize.

Bankruptcy laws also may help America compete in the global economy. Some of our European trading partners think the ability to reorganize gives American companies an "unfair trading advantage." But there's nothing "unfair" about sensible economic policy. If Europeans worry that their companies are uncompetitive, they should fix their own laws and stop criticizing America's more successful approach.

Risk-taking and entrepreneurship fuel economic growth -- and this explains why the dark cloud of bankruptcy has a silver lining. Most small businesses fail, but the ones that succeed are America's chief innovators and job creators. America's entrepreneurial culture promotes this economic dynamism, partly because it's understood that the ability to succeed goes hand-in-hand with the ability to fail.

Corporations employ tens of millions of workers, pay tens of billions in taxes, and help keep America competitive in the global economy. Yet many politicians make "big business" a political whipping boy. This is shortsighted. Instead of bashing corporations, lawmakers should improve economic policy.

Tax reform would be a good place to start. The United States has the fourth-highest corporate tax rate in the developed world. And with Belgium and Italy planning to lower their business tax rates, America soon may have the unwanted distinction of imposing the industrial world's second-highest tax burden.

But lower tax rates are just a start. Policy-makers also should eliminate the "double taxation" of corporate income; taxing dividends at both the corporate level and the individual level discourages investment. It also encourages companies to assume too much debt, which is part of the reason some firms wind up declaring bankruptcy.

President Reagan once summed up the big-government view of the economy like this: "If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it." He was right. Let companies compete to win, and avoid the temptation to interfere when they fail.

About the Author

Daniel J. Mitchell, Ph.D. McKenna Senior Fellow in Political Economy

Distributed nationally on the Knight-Ridder Tribune wire.